The insouciant debtor

Time to deal with the unpaid bills

ECONOMIC analysis in Argentina today is a bruisingly ideological matter, conditioned by disagreements over the causes of the collapse. Some see the current recovery as ephemeral, resulting largely from the soya boom. They accuse the government of abandoning the reform agenda of the 1990s and failing to repair the numerous breaches of contract caused by the devaluation. Mr Kirchner “hasn't confronted any of the problems. We devalued to save the same fiscal and labour-market institutions that led us to crisis,” says Ricardo López Murphy, an orthodox liberal who came third in last year's presidential election.

Others see Convertibility as a costly straitjacket that the country did well to wriggle out of. The economy has recovered “because, finally, after ten years, producing tradable goods is profitable again,” and because “macroeconomic policy is the most orthodox in 50 years,” says Javier González Fraga, a former central-bank governor. Certainly the main aggregates look healthy enough. Inflation is running at 3-4%; interest rates are low; and thanks partly to windfall taxes on exports, the public finances showed an unprecedented primary surplus (ie, before debt payments) of 3.4% of GDP in the 12 months to March.

Mr Lavagna, the economy minister, urges outsiders to separate Argentina's “stock of crisis”, which he calls a “very high sunk cost” for the country's firms, its people and its credibility, from these “very positive” flows. It is a neat formulation. Arguably, it was right to concentrate on getting the economy growing again before dealing with the bills for the wreckage. Unfortunately, matters are not so simple. Argentina's recent past is rapidly catching up with it, threatening to hobble recovery and hence progress on reducing poverty.

Several broad issues remain partly or wholly unresolved. One is Argentina's economic relations with the outside world, and particularly with the IMF. That includes the debt default. Another is the banking system, which remains in a state of near-paralysis. The privatised utilities are also operating in limbo (see article). Lastly, there is the need to reverse Argentina's chronic fiscal weakness. All of these issues are linked. Argentina needs to decide, first, how big a primary fiscal surplus it can achieve and how it should be spent; and second, how the government should behave towards the private sector.

Take the IMF first. Critics claim it has again caved in to Argentina. A three-year agreement signed in September 2003 was widely seen as generous, setting a fiscal target of a primary surplus of 3% of GDP in the first year, compared with Brazil's 4.3% and Turkey's 6.5%. Officials retort that Argentina's situation is different. The government is spending 1.5% of GDP on the transitional cost of its radical pension reform. And unlike Brazil and Turkey, it is receiving no new money from the IMF or the World Bank. The Fund has agreed to lend Argentina only what the country is due to repay to it over the next three years, a total of $12.5 billion. Indeed, in 2002-03 the government made net repayments to international financial institutions totalling $6.6 billion.

A fund of disagreement

But the most important difference is political. When George Bush's administration took office in 2001, it initially disapproved of the IMF propping up emerging-market governments. It changed its mind when Argentina's default and collapse threatened to contaminate the rest of South America in 2002. Since then, it has worked hard to avoid being blamed for any further turmoil. The IMF itself has much at stake: its lending to Argentina makes up 15% of its total loans. Cutting the country off would mean acknowledging huge bad loans. All this gives Argentina leverage.

But Mr Kirchner's truculence has won him few friends abroad. His government refused to start serious negotiations with its bondholders, and he played a game of brinkmanship with the Fund itself, refusing to make payments to the IMF without assurances that the Fund would pay up in return. The United States has since joined its G7 partners in pressing Argentina to strike a deal with its creditors.

Some believe that a turning point has been reached. Since March, Mr Kirchner has adopted a less abrasive stance towards the Fund; his government has appointed four investment banks to advise on the debt negotiations, and has held a preliminary meeting with bondholders. But there will be plenty of further argument.

The cost of pesification

The debt talks are more complex than previous sovereign restructurings, involving 152 different bonds under eight different legal jurisdictions. The bondholders range from Japanese pensioners to New York “vulture” funds, as well as Argentine institutions. Moreover, Argentina's public debt has swelled since the collapse (see table 4). To compensate banks and depositors for Mr Duhalde's “pesification”, the government issued new bonds called BODENs. It says it will honour these, together with its loans to international financial institutions and “guaranteed” loans that Mr Cavallo foisted on Argentine banks and pension funds in 2001.

That means, Mr Kirchner maintains, that the government can offer holders of the defaulted bonds only 25% of their face value. In net-present-value terms, that amounts to just 10 cents in the dollar, say outraged bondholders. They want at least 75 cents. That may not be an unbridgeable gap. Argentina will now “make [its offer] more precise,” says Mr Lavagna. “The idea is to do a bit of financial engineering to make it as attractive as possible within the limits of the Argentine situation.” In net-present-value terms, the offer will be “not less than 25%”.

The government insists it will not borrow more to repay the debt, nor will it agree to do a deal that it cannot be sure of honouring for years to come. It also says a primary surplus of 3% is a ceiling for future years. The IMF considers it a floor. The agreement commits Argentina to “a rising trend”, says Anoop Singh, the IMF's chief for the western hemisphere. The longer the talks drag on, the more likely it is that creditors will turn to the courts (so far only three have filed suits in New York). However, Argentina does have incentives to settle. “Problem number one is the debt. Not settling it is delaying many other things,” says Mr González Fraga. Without a deal, he says, the country's bigger companies will be unable to raise money and the government cannot implement tax reforms. And uncertainty will continue to hang over the banks.

Two years ago, many banks in the centre of Buenos Aires, besieged by angry depositors, boarded up their frontages. Now, outwardly everything has returned to normal. The freeze on deposits ended a year ago. Deposits have flowed back and now stand at 90 billion pesos, compared with 80 billion before the collapse. But the financial system is acting as little more than a piggybank. Things have improved, concedes Mario Vicens of the Argentine Banking Association, which represents foreign banks with branches in the country, but not yet enough to ensure the normal operation of the financial system.

The main problem is on the banks' asset side. Nearly half their operating assets are in government paper (some of it Mr Cavallo's “guaranteed loans”, the rest the bonds issued to compensate for pesification). This debt, though in good standing, has been issued by a government in default, so nobody knows what its real value might be. And it pays a low interest rate: 3.5% plus inflation.

A second source of uncertainty is a number of injunctions issued by the courts to savers who demanded that their dollar deposits be paid at the market exchange rate, rather than the rate decreed by the government of 1.40 pesos to the dollar, plus inflation. Honouring these injunctions has so far cost the banks an extra 7 billion pesos. The Supreme Court is due to rule whether pesification was legal.

The Central Bank reckons that the banks should treat the excess paid to depositors who won injunctions as a loss, which it will allow them to write off over five years. It has also given them time to increase their capital base. At the end of 2001, the banking system's net worth was $16 billion. Today it stands at $8 billion—provided government bonds are worth their face value. “Since we didn't have money, we had to offer time,” says Alfonso Prat-Gay, the central-bank governor. “There's still a lot to be done, but the ball is now in the banks' court.” In other words, they will have to start lending again.

The Central Bank's rules are reasonable, says Mr Vicens. But the banks face a long road back to profitability. At least the system is now roughly breaking even, after losses of 16 billion pesos in 2002 and a further 4 billion pesos last year. Only a handful of banks have closed their doors. A new crop of regional private banks are expanding—as are two big and poorly managed state-owned banks, perhaps sowing the seeds of the next financial crisis.

Banks and borrowers are still proceeding with caution. Most deposits are short-term, which limits the scope for long-term lending. Loans are starting to grow again, but so far most of them are short-term consumer credits. Today, Argentina is a cash economy: credit to the private sector amounts to only 8% of GDP. Miguel Kiguel, an economic consultant, thinks the banking system could return to solvency over the next five years—but only if deposits and loans go on rising, the economy grows by at least 3% a year and the government continues to service its debts to the banks.

Fiscal errors

The debt burden means the government has no margin for fiscal error, a lesson that the collapse of 2001-02 may have driven home. Mr Singh of the IMF is cautiously optimistic on that score: “I don't think the Argentine population will tolerate high fiscal deficits and inflation any more. There may have been a culture shift.” To make sure, the IMF wants the revenue-sharing arrangements with the provinces to be reformed, but that may prove difficult. To comply with the IMF agreement, Mr Lavagna duly sent a bill to Congress in March, but it merely guarantees provinces the same money they got last year and suggests that any excess should go to poorer and more efficient provinces. Miguel Angél Broda, an economic consultant, thinks this does not go nearly far enough. “We're taking a bonanza year and extrapolating it for ten years. It's missing a historic opportunity to reform the relationship with the provinces,” he says.

Yet the bill's authors may have gauged the political temperature correctly: even this mild draft was immediately howled down by several provincial governors. Under the constitution, changes in revenue-sharing must be approved by every province as well as by the federal Congress, so the IMF should not hold its breath.

In fact, since the Menem reforms, government spending has not been egregiously high. The problem is that the government spends badly and fails to collect enough taxes. A more promising approach may be to reform the tax system, and ensure that taxes are actually paid. Mr Lavagna says that his priorities for this year, along with revenue-sharing reform, include lowering taxes on investment and cracking down on evasion. In this area, too, establishing the rule of law is essential.